Election Weekend

Elections were held in Greece and France at the weekend, and in our judgement, the results of the Greek elections in particular have adverse consequences, in the medium term, for the stability of the eurozone. The damage, however, was by no means unexpected and the threat is not immediate.

In France, Francois Hollande, the Socialist Party candidate, beat incumbent President Sarkozy by about 52% to 48% in the second and final round of the presidential election. To us, the key issue is not what Hollande said he would do during his campaign (his policy statements included commitments to raise taxes, change existing EU agreements and treaties, and put pressure on the European Central Bank to directly fund governments), but the extent to which he will implement this in practice once in power. In this context, there are several important items to note:

M. Hollande will of course be President, and as such be the most important politician in France, but parliamentary elections are due next month and we do not yet know whether or not the Socialist Party, or left wing parties in general, will have control of the new parliament. In circumstances where control is "split" between a left wing presidency and a right wing parliament - if that was to occur - it would obviously be considerably harder for M Hollande to implement his more controversial policies.

It is of course very common in politics - in Europe and in France, as elsewhere - for an elected official's policies to be considerably less radical once in office than those proposed when the politician is running for election. France has had a socialist president before (Francois Mitterand) for 14 years, but his policies were arguably, in practice, not significantly more left-wing in economic terms than his right wing predecessors. It is therefore quite possible that once in office M. Hollande will resile from some of his more radical policies and rule in a more pragmatic fashion, once freed from the need to appeal to his left-wing base until the next election. However, needless to say we cannot be sure of this.

M Hollande's commitment to add a "growth dimension" to accompany the austerity driven set of policies that currently strongly dominate the policy agenda in Europe is interesting, and is broadly in line with the way in which this debate has been moving across Europe generally in recent weeks. It seems now that there is a possibility that - for those countries that have a choice, i.e. those that can continue to fund themselves at reasonable rates in the financial markets - there could be a modest realignment of policies towards a more growth-friendly stance. This could be seen as a positive by the financial markets if managed carefully.

Meanwhile in Greece the two large parties which have dominated Greek politics suffered very substantial losses, and a variety of splinter parties and far right and far left parties made very major gains. This was broadly in line with expectations. New Democracy and Pasok, the two pro-austerity parties, will hold 149 of the 300 seats in parliament, i.e. short of an overall majority.

The fact that the two "establishment" parties appear not to have gained a majority is a serious issue. Firstly it should be noted that between them they obtained only about one third of all votes cast, down from close to four-fifths in previous elections. Or to put it another way, anti-austerity parties, who want to walk away from or renegotiate the bailout deal with the EU, won about two-thirds of all votes.

Secondly, although it appears the two parties may - possibly - be able to combine with one or more of the smaller anti-austerity parties to form a majority of seats in parliament, it is far from certain that this can happen given the sharp policy differences. Already the leader of the largest party has formally abandoned attempts to form a coalition, after a fairly token attempt which lasted only six hours. At this stage it looks quite likely that no government will be formed, and a second set of elections will be held in a few weeks time.

However, even if a coalition government is formed, it is likely to be unstable, particularly in the context of the extremely tough austerity programme that needs to be implemented over the next few years. If a few members of parliament were to balk at a tough decision, and defect from the government side in a vote, the government could lose its majority.

There is therefore a real possibility that Greece will at some point walk away from its deal with the EU/IMF and refuse to implement further austerity measures. It is unlikely that the deal could be renegotiated as the EU/IMF had to "stretch" a long way to agree to the last Greek bailout, so the most likely scenario, in those circumstances, is that the EU and IMF would cease to provide funds to Greece. And that in turn would imply a high probability of a Greek exit from the euro.

Finally, notwithstanding the preceding conclusions, we must acknowledge that a Greek exit from the eurozone has been "on the cards" for some time now, and European financial institutions have had a long lead-in period during which to make preparations for that scenario. The eurozone banking system is unlikely, in our view, to be seriously threatened by a Greek exit, but on the other hand the bigger risk is the contagion effect, where the markets start to worry that Portugal or Spain or Ireland might follow the Greek precedent. That contagion impact can't be ruled out, but on the whole we remain of the view that the fiscal and policy situations in those countries is very substantially different - and better - than in Greece, and so contagion effects would be limited. Should contagion take hold, we would expect to see the European Central Bank take a very central role in the policy response.

HTML is disabled and your e–mail address won't be published. Comments will be deleted if commenters leave a keyword instead of a name in the name field, if sites linked in the URL field are commercial in nature and not related to the blog, or if the comment simply doesn't add substance to the discussion.

Your Name

Email

Website http://

Comment

Spam Prevention

In order to submit this form successfully, you must complete this question